Chapter 13: Measuring the performance of the economy CHAPTER OUTLINE LEARNER OUTCOMES INTRODUCTION 13.1 MACROECONOMICS OBJECTIVES 13.2 MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GROSS DOMESTIC PRODUCT 13.3 OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE 13.4 MEASURING EMPLOYMENT AND UNEMPLOYMENT 13.5 MEASURING PRICES: THE CONSUMER PRICE INDEX 13.6 MEASURING THE LINKS WITH THE REST OF THE WORLD (BALANCE OF PAYMENTS) 13.7 MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME IMPORTANT CONCEPTS Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LEARNER OUTCOMES Once you have studied this chapter you should be able to • explain the five main macroeconomic objectives • explain what the national accounts represent • define the most important national accounting concepts • show how the basic national accounting concepts are linked • define the unemployment rate • define and interpret the consumer price index (CPI) • explain the balance of payments • explain a Lorenz curve and the Gini coefficient Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY INTRODUCTION How is the economy performing? What are our economic prospects? Are things going to improve and, if so, when? This leads the economist to ask…. What criteria should be used? How can these criteria be quantified or measured? Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Explain the five main macroeconomic objectives 13.1 MACROECONOMICS OBJECTIVES The five macroeconomic objectives Economic growth Click to edit Master title style Full employment Price stability ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY Balance of payments stability Equitable distribution of income LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked 13.2 MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GROSS DOMESTIC PRODUCT • The first step in measuring economic growth is to determine a country’s total production of goods and services in a specific period. • Performed by the national accounting sections of Statistics South Africa (Stats SA) and the South African Reserve Bank (SARB). • The central concept in the national accounts is the gross domestic product (GDP). Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Defining GDP The gross1 domestic product is the total value2 of all final3 goods and services produced within the boundaries of a country4 in a particular period5 (usually one year). 1 Gross: No provision for depreciation, consumption of capital 2 Value: expressed in terms 3 Final goods and services: value added: to avoid double counting 4 Geographic aspect: within a country’s boundaries 5 CurrentClick production: during a particular period on the corresponding numbers to examine the elements of the definition Click again to hide Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Defining GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked GDP = C + I + G + (X – Z) Investment Exports Imports Consumption Click to edit Master title style Government spending ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Three methods of calculating GDP 1 2 3 Click to edit Master title style Production method (value added) Expenditure (final goods and services) Productionmethod method (value added) This method estimates GDP by adding up the contribution of each Income method (income of the factors ofservices) production) industry to GDP. To avoid double counting, the contributions are Expenditure method (final goods and measured in terms of value added. Uses basic prices. The expenditure method estimates GDPofbyproduction) adding up all the WhyIncome do they yield the same answer? method (income of the factors components of final demand. To avoid double counting only the expenditure on essentially final estimates goods measure andGDP services (e.g the bread) should income method by adding up all the incomes The The three methods the same thing, albeit at be considered. Uses market prices. (rent, interest, wages & profits) different points in the circular flow.received by the FOP. Uses factor cost. ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Three methods of calculating GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked One of the major problems that national accountants have to deal with is the problem of double counting. An example Add the totals of each • A farmer produces 1 000 bags of wheat which he sells sale:to a miller at R10 per bag, yielding a total of R10 000. R10 000 • The miller processes the wheat into flour, which he then + sells R12 500 to a baker for R12 500. + R18 000 • After baking bread with the flour, the baker sells it to a+ shop R21 000 for R18 000. = R61 500 • The shop subsequently sells the bread to final consumers for R21 000. You need to consider the value ? add for each transaction • What is the value of these four transactions Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY Click on the question mark for more Click again to hide MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked What is the value add? The amount by which the value of the firm’s products exceeds the value of the goods and services the firm purchases from other firms at each stage of production. Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Three methods of calculating GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Let us look at each method: 1 Production method Click on each letter to view the steps of the example. Click again to hide This method estimates GDP by adding up the contribution of each stage to GDP. Value added A farmer After The miller shop baking produces subsequently processes bread 1with 000 thesells the wheat bags flour, the ofinto bread wheat theflour, baker to A B C D E Click to edit Master title style final it which sells consumers he to athen sells shop to sells for for a miller to R21 R18 a baker 000. 000. at R10 forper R12 bag, 500. yielding a total of R10 000. Value added = R21 R12 000 R18 500 – R18 R10 000 R12 500 His value added = R3 R2 R5 is R10 500 000 000 Calculate the total value added by adding up the value added per stage ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY R10 000 R2 500 R5 500 R3 000 R21 000 RESET MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Three methods of calculating GDP 2 LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Expenditure method The expenditure method estimates GDP by adding up all the components of final demand. This is the sum of the spending by households, firms, the government and the ROW on final goods and services produced in the domestic (SA) economy. Or The expenditure approach measures GDP as the sum of consumption expenditure, investment, government purchases of goods and services, and net exports. GDP = C + I + G + (X – M) Click on the number to reveal. Click again to hide Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Three methods of calculating GDP 3 LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Income method The income method estimates GDP by adding up all the incomes (rent, interest, wages and profits) received by the factors of production (land, capital, labour and entrepreneurship) during the various stages of the production process. Click on the number to reveal. Click again to hide Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Measurement at market prices, basic prices and factor cost (or income) The three sets of prices that can be used to calculate GDP 1 Market prices (used in expenditure method) 2 Basic prices (used in production method) 3 Factor cost (used in income method) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Measurement at market prices, basic prices and factor cost (or income) LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked • GDP at market prices – taxes on products + subsidies on products = GDP at basic prices • GDP at factor cost (or income) + other taxes on production – other subsidies on production = GDP at basic prices • GDP at basic prices + other subsidies on production – other taxes on production = GDP at factor cost (or income) • GDP at basic prices + taxes on products – subsidies on products = GDP at market prices Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Measurement at current prices and at constant prices • Measurement always first at current prices (nominal GDP) • During inflation, adjustments for price increases required − nominal GDP converted to real GDP − use prices in a base year (constant prices) • GDP at current prices = nominal GDP (reflects price changes) Click on the triangle to reveal Table 13-2 GDP at current prices and constant prices and nominal and real growth, 2000-2013. Click again to hide. Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LEVEL OF ECONOMIC ACTIVITY: GDP Measurement at current prices and at constant prices LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked • GDP at constant prices = real GDP (excludes price changes) • In base year: Or real GDP = nominal GDP GDP at constant prices = GDP at current prices See Box 13-1: Nominal values, real values and purchasing power (Textbook page 239) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked 13.3 OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE Gross national income or gross national product • GDP: geographical concept; reflects what happened on SA soil, irrespective of who created the product • We also want to know what happened to the economic position of South Africans Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE Gross national income or gross national product • GNI (= GNP) = LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked GDP all income earned in South Africa by foreign factors of production all income earned by South African factors of production in the rest of the world Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Expenditure on GDP Let’s recap: The elements of total spending Three approaches to four calculating the GDPof the economy The major sectors Three approaches to calculating the GDP (C) •• consumption expenditure by households Households • Production approach investment spending (or capital formation) by The four major sectors of the economy • Firms • Income approach firms (I) • Government • Expenditure approach government spending (G) • Foreign sector The elements of total spending • expenditure on exports (X) minus expenditure on imports (Z) Click on the arrows for more information Click again to hide Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE EXPENDITURE ON GDP CONTINUED LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked GDP = expenditure on GDP =C+I+G+X–Z Table 13-3 Composition of expenditure on GDP in South Africa in 2013 Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE Expenditure on GDP LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Gross domestic expenditure (GDE) GDP = C+I+G+X–Z = GDP at market prices Gross domestic expenditure (GDE) = total value of all spending in South Africa = C+I+G • Exports (X) excluded from GDE because expenditure occurs in the rest of the world • Imports (Z) included in GDE (ie not subtracted) because expenditure occurs in SA Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY OTHER MEASURES OF PRODUCTION, INCOME AND EXPENDITURE LO: Explain what the national accounts represent LO: Define the most important national accounting concepts LO: Show how the basic national accounting concepts are linked Relationship between GDE and GDP • GDE = C + I + G • GDP = C + I + G + X – Z Thus: GDP = GDE + (X–Z) If GDP > GDE, then X > Z (ie (X–Z) is positive) If GDP < GDE, then Z > X (ie (X–Z) is negative) Important point The difference between domestic spending and domestic production is reflected in the balance of payments. Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Define the unemployment rate 13.4 MEASURING EMPLOYMENT AND UNEMPLOYMENT number of unemployed persons 100 Unemployment rate = ——————————————— x —— workforce (available workers) 1 Strict definition: only those who have looked for work but not found any Expanded definition: everyone who desires employment and does not have a job See Box 13-3 The informal sector (Textbook page 245) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Define and interpret the consumer price index (CPI) 13.5 MEASURING PRICES: THE CONSUMER PRICE INDEX Prices and purchasing power Purchasing power: The real value of money; what amount of goods or services can be bought with one unit of money. See Box 13-4 Index numbers (Textbook page 247) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING PRICES: THE CONSUMER PRICE INDEX LO: Define and interpret the CPI The consumer price index • CPI = index of prices of representative basket of consumer goods and services • Elements of CPI: basket weights base year formula price collection • CPI serves as basis for measuring inflation Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING PRICES: THE CONSUMER PRICE INDEX The consumer price index LO: Define and interpret the CPI Table 13-5 The South African consumer price index (all urban areas), 2012 and 2013 (December 2012 = 100), seasonally adjusted Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING PRICES: THE CONSUMER PRICE INDEX LO: Define and interpret the CPI Constructing a price index By using the prices and the contents of the CPI basket it is possible to calculate the CPI. The formula is: Cost of basket in current period * 100 Cost of basket in base period Furthermore, note that a major purpose of the CPI is to measure inflation. The inflation rate is the percentage change in the price level from one year to the next. The inflation formula is: (CPI of this year - CPI of the previous year) * 100 CPI of the previous year Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING PRICES: THE CONSUMER PRICE INDEX LO: Define and interpret the CPI Constructing a price index See Box 13-5 Constructing a price index (Textbook page 247) Lets work through the example in Box 13-5. Year Bread Total cost of basket Qty (kg) Price per kilo Total cost of meat Qty (loaves) Price per loaf Total cost of bread 2012 4 R35 R140 10 R10 R100 R240 2013 4 R45 R180 10 R12 R120 R300 1 2 Click to edit Master title style Meat Click on the numbers to reveal more information Click again to hide Total cost of basket in 2013 (current period) Calculate the total price per basket for each year.X 100 Total cost of basket in 2012 (base period) 2012 = (4 X R35) + (10 X R10) = R140 + R100 = R240 300 100 =+125,0 2013 = (4 X R45) + (10 x R12) =X R180 R120 = R300 240 ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY 25% MEASURING PRICES: THE CONSUMER PRICE INDEX LO: Define and interpret the CPI Changes in purchasing power Purchasing power: The real value of money; what amount of goods or services can be bought with one unit of money. See Box 13-6 Changes in purchasing power (textbook page 249) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Explain the balance of payments 13.6 MEASURING THE LINKS WITH THE REST OF THE WORLD (BALANCE OF PAYMENTS) • Summary of all transactions with the rest of the world Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LINKS WITH THE REST IF THE WORLD: BALANCE OF PAYMENTS LO: Explain the balance of payments Table 13-6 South Africa’s balance of payments, 2012 and 2013 Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING THE LINKS WITH THE REST IF THE WORLD: BALANCE OF PAYMENTS LO: Explain the balance of payments Key elements Current account A record of all the sales of goods and services Current account Financial to the restaccount of the world (exports), all the purchases A allservices international transactions assets ofrecord goods of and from the rest of theinworld Unrecorded transactions Financial account and liabilities all the purely financial flowsand in (imports) and (i.e. all the primary income receipts All errors omissions that occur in compiling Gold and and foreign reserves and out of of a country, like purchases and sales of payments a country. the individual the balance Assets held oncomponents reserve by a of central bank inof assets such(+) as bonds and shares). - Exports Unrecorded transactions payments. Unrecorded transactions ensure that foreign currencies and gold - Direct investment Imports (–) the balance of payments balances. Portfolio investment Service receipts (+) Gold and other foreign- services - Other Serviceinvestment payments (–) - Income receipts (+) - Income payments (–) Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY LO: Explain the Lorenz curve and the Gini coefficient 13.7 MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME Three of the measures used to calculate: 1) Lorenz curve 2) Gini coefficient 3) Quantile ratio Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME LO: Explain the Lorenz curve and the Gini coefficient 1) Lorenz curve The Lorenz curve is a simple graphic device which illustrates the degree of inequality in the distribution of income (or any other variable). Constructing a Lorenz curve Click on the animation icon and work through the steps Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME 2) Gini coefficient LO: Explain the Lorenz curve and the Gini coefficient Click on the triangle to work through the definition for the Gini coefficient. Click again to hide. Gini coefficient = area of inequality shown in the Lorenz curve Area of the right angled triangle formed by the axis and the line of equality RESET Gini index Click to edit Master title style Gini index = Gini coefficient x 100 ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME LO: Explain the Lorenz curve and the Gini coefficient 3) Quantile ratio Quantile ratio = Click to edit Master title style income received by the highest per cent of the population income received by the highest per cent of the population ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY MEASURING INEQUALITY: THE DISTRIBUTION OF INCOME LO: Explain the Lorenz curve and the Gini coefficient The distribution of income in South Africa Gini index 68 Gini coefficient 0,68 Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY IMPORTANT CONCEPTS Economic growth Full employment/unemployment Price stability/inflation Balance of payments (or external) stability Distribution of income Gross domestic product (GDP) Final and intermediate goods Value added Production method Expenditure method Income method Market prices Basic prices Click to edit Master title style Factor cost Current prices Constant prices Nominal GDP Real GDP Gross national income (GNI) Net primary income payments Consumption of fixed capital Gross domestic expenditure (GDE) Purchasing power Specific index General (composite) index Consumer price index Balance of payments ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY IMPORTANT CONCEPTS CONTINUED Current account Financial account Trade balance Direct investment Portfolio investment Other investment Unrecorded transactions Gold and other foreign reserves Gross reserves Net reserves Lorenz curve Gini coefficient Gini index Click to edit Master title style ECONOMICS FOR SOUTH AFRICAN STUDENTS CHAPTER 13: MEASURING THE PERFORMANCE OF THE ECONOMY